Smartgroup Corporation Ltd (SIQ) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Smartgroup Corporation SIQ Annual Results 2020 Briefing. [Operator Instructions] I would now like to hand the conference over to Tim Looi, Chief Executive Officer. Please go ahead.

Thank you, Matt. Good morning, everyone. Thank you for joining us today on the call. My name is Tim Looi, I'm the Managing Director and CEO of Smartgroup. Joining me on the call today is Anthony Dijanosic, our interim CFO. So Anthony joined us in 2016 to manage our finance function. He's also have been integral to Smartgroup's growth strategy as well as managing suppliers, banking relationships and parts of our operations. Anthony and I will provide an overview of our financial performance for the past year. We'll take you through some key operational highlights, and then we'll take your questions. Now let's turn to the investor presentation. It is a testament to the dedication and hard work of our team and the strength of our business that in a challenging year, Smartgroup is able to deliver a good set of results for 2020 while continuing to progress simplification and efficiency initiatives in all aspects of our business. Now we're all aware of the broad impact of the pandemic had on our economy, our society and the changes it has brought to our ways of working. Like most businesses in the country, we had to deal with a rapid onset of operational challenges and as the financial impact of this crisis. We implemented cost containment measures early. We quickly transitioned our workforce to remote working and replaced face-to-face interactions with our customers with phone, digital or web channels. The highlights from 2020 results are as follows. First, we delivered revenues for the full year of $216.3 million and NPATA of $65.2 million, slightly higher than the expectations announced to the market in late 2020. Top and bottom line numbers, however, are down on the prior year by 13% and 20%, respectively. Second, we continue to make steady progress in what was a challenging operating environment. We renewed or extended 100% of the top 20 client contracts maturing in 2020. Packages, novated leasing and fleet metrics are steady. Third, we continue to simplify our business operations, resulting in $4 million of annual cost savings. We have continued to streamline our systems, retiring the Selectus salary packaging platform ahead of schedule. We're also making good progress in the ongoing rationalization of another legacy system. And finally, our capital-light business model means we generate a strong level of free cash flows. After-tax cash flows at 115% NPATA, and we have moved to a net cash position. This strong financial position has allowed us to declare a final ordinary fully franked dividend of $0.175 per share and to declare a special fully franked dividend of $0.145 per share. Now turning to Page 3. Our revenue stream for novated leasing fell in 2020, and this financial impact was partially offset by cost containment measures. As a result, we still maintain a strong EBITDA margin of 44% for the year. Now our capital-light business model together with the stronger balance sheet means we've been able to maintain our dividend payout ratio as well as declare a special dividend this year. This brings the total dividend of $0.49 per share fully franked. This payout equates to 100% of our earnings for 2020. Now turning to Page 4. In 2020, we operated much of the year with reduced in-person site visitations and client interactions. This traditionally has been a strong channel that generates interest and demand for our business. So despite the material downturn in visitations, our customer base of salary packaging remained stable over the full year, with some growth in customers experienced in the second half of 2020. Late last year, Smartgroup won a new health client with around 3,500 salary packaging customers. We were also added to the novated leasing panel for 4 government departments throughout the year. We are expecting site visitations to increase in 2021 as various clients progressively reopen to on-site visitations. Our salary packaging customer profile remains largely unchanged, with 96% of our customers working in attractive sectors with charities, age care, health care, education and government. Turning to Page 5. Smartgroup has strong long-term relationships with key clients, with most having undergone multiple renewal cycles. On this page, we highlight the strength of our relationships with our top 20 clients. Our contracts with clients are typically long-term with 3 to 5 years being common terms. Whilst we're subject to a renewal process on these contracts, more than 70% of our key clients have been through multiple contract renewals. We credit this to the strong customer-centric values of our business and our team members. So we renewed or extended 100% of key client contracts that fell due last year. We have a similar number of renewals in 2021, and the client discussions are progressing well. Now turning to Page 6. Our novated leasing business saw a fall in volumes, particularly in the initial phases of the pandemic with country-wide lockdowns in place. We have seen a progressive recovery throughout the second half of 2020 and into the first week of 2021. However, order fulfillment continues to be impacted by new car supply shortages. Now on Page 7, you can see that our novated leasing volumes reduced by around 14% and year-on-year. Now according to VFACTS, the broader car market reduced by around the same level with private new car sales performing better. New novated leases as a proportion of total leases decreased to an average of 74% in 2020 compared to 78% in the prior year. The shift by consumers away from new leases to refinancing existing leases together with the repricing of our insurance products from July 2020 is evident in the reduction in yields. Excluding these factors, yields would have been remained relatively stable throughout the year. New novated leases as a percentage of total novated leasing volumes has improved progressively throughout the year from the low of 2 and 3 novated leases in May to around 3 and 4 currently in line with historical levels. We are off to a positive start for 2021, with novated leasing leads 15% higher than the half 2 2020 monthly average. The mix has also improved. Now turning to Page 8. There is now increased certainty regarding the regulation of add-on insurances. Now treasury's proposed legislation on the deferred sales model for the sale of add-on insurance products was passed by parliament late last year. A compliance with this is required by the 5th of October 2021. ASIC has also confirmed that its revised product intervention order will not apply to motor vehicle add-on insurance other than to extended warranty. We've already commenced work to ensure compliance with these changes to regulations. The necessary modifications to our existing processes and systems is on track to be in place by the deadline. Now together with these changes, we're also taking further steps to enhance our disclosure for novated leasing. On Page 9, this shows the progress we have made and are continuing to make to integrate historical acquisitions to operate more efficiently. So we completed the transition of the Selectus clients to continuing brands midway through 2020. This was achieved ahead of plan. Clients and customers are now benefiting from more automation and high levels of service. We continue this progress with the integration of Advantage. Now moving to Slide -- to Page 10. We play a part in the broader community. Our strength as a business comes from diversity, experience and skills of our team members. Last year, Smartgroup joined a group of only 119 Australian companies recognized as an employer of choice for gender equality by the Workplace Gender Equality Agency. Our workplace diversity is also reflected in our rating as an inclusive employer by the Diversity Council Australia. In service excellence, Smartsalary continues to maintain its high standings with the Customer Service Institute of Australia, the peak body for service quality. Lastly, the work done by the Smartgroup Foundation this year reinforces our commitment to supporting the not-for-profit sector and the communities that we work with and service. The foundation supported 11 organizations and their projects from an early literacy program for children living in disadvantaged communities to supporting young mothers in continuing their education. So we are proud of our commitment to the community, the strength of our team, which comes from supporting diversity in the workplace. Now let me hand you over to Anthony, who will take you through the financial results in more detail.

Thank you, Tim. Turning to the profit and loss on Page 12, you'll see that like many other businesses, the lockdowns and the general business disruption resulting from the pandemic has had a significant impact on our revenue. Much of our revenue comes from novated leasing. The fall in volumes, which commenced in April of 2020 and the shift towards refinancing, which results in lower yields, both reduced revenue. Revenue was also impacted by the previously disclosed add-on insurance repricing that became effective on 1 July 2020. This has had the effect of reducing revenue by about $2.5 million in the second half of the year. As Tim has detailed, in May and June, we took steps to simplify our business operations resulting in annual savings of around $4 million when compared against 2019 staff costs. Half 2 staff costs are lower than we would generally expect due to a higher than usual level of vacancies. Other overheads increased around $1 million compared to 2019, and this is largely a result of increased spend on projects as we continue to consolidate acquired brands. I also draw your attention to net finance costs, where you will see a heavy skew to the first half as a result of the one-off debt refinancing charge. This was, however, largely offset in the second half, which benefited from lower interest charges as a result of the debt repayment. When considering net finance charges for the full year, the total is in line with 2019. In March 2020, like many other organizations facing economic uncertainty, we took steps to ensure we had the liquidity shored up that we required by drawing down on an additional $38 million of debt, and then refinanced our existing debt facilities early. In refinancing, we incurred a $1.3 million one-off debt refinancing charge upfront, reflecting the extra interest that we would be paying over the remaining life of the facilities. However, throughout the year, we continued to generate strong cash flows, and as a result, our cash balance grew beyond our working capital needs. So in December, we made the decision to pay down around $74 million of outstanding debt. In doing so, we benefited from $1.2 million P&L credit, reflecting the future interest that we would no longer have to pay. We would also like to point out that Smartgroup did not require JobKeeper assistance at any time during the year. At no point in any month did Smartgroup suffer a financial loss with cash flow also remaining positive every month. Page 13 shows the high level of operating cash that our business continues to generate, reflecting our capital-light model. The increase in capital expenditure to $1.2 million reflects IT equipment purchase to enable team members to work remotely. And moving to the balance sheet on Page 14. You will see that our cash position is strong at the end of 2020 with significantly reduced borrowings. The paydown of noncurrent debt has resulted in a small excess of current liabilities over current assets, but obviously, with our strong cash flow generation, this should be short lived. We are now in a net cash position of $2.5 million, and we have around $20 million of undrawn loan facilities available. The reduction in other current assets primarily relates to a reduction in restricted cash, which are funds that belong to our salary packaging customers for the purposes of making packaging payments. There's an equivalent salary packaging liability, and both the asset and the liability reductions from 2019 are due to the timing of client payroll processing runs. I'll now hand back to Tim.

Thank you, Anthony. Now turning to Page 16. We continue to improve our business, focusing on experience, digital and simplification. We've started to roll out experience training to frontline team members, and we're seeing improving results following a group-wide rollout of Net Promoter Score. To help drive our focus on enhancing the customer experience, we have commenced recruitment for the new role of Chief Customer Officer. On the digital front, we continue to consolidate acquired businesses, allowing us to retire legacy IT platforms. We've also formed an in-house intelligent automation team to reduce manual work and increase accuracy. Now in the area of simplification, our organization structure has become less complex with duplicated roles removed throughout the restructure. We have also refreshed our company values to reflect our one company, one team culture. Our new values, accountability, care, and team will help us strengthen our one team, one company culture, foster positive and respectful working relationships and give clear direction on what we stand for. We have also undertaken a comprehensive review of our remuneration structure, replacing a complex set of incentives with a simpler and more transparent measurement program. Turning to Page 17. And in summary, we're pleased to be able to report that Smartgroup has delivered a good set of results for 2020 in the context of the business disruptions resulting from the pandemic. During 2020, we also continue to progress operational efficiency initiatives across all aspects of our business. Our business model is capital-light. It generates strong cash flows. This has enabled us to maintain a strong dividend payout ratio as well as declare a special dividend for our shareholders. Looking forward to 2021, we're off to a good start. We are pleased to sign on another large health client with 8,000 packages to be onboarded in Q2 2021. Novated leasing leads are more positive than the last 6 months. The level of new novated leases is also trending stronger, with January at 76% versus the prior 6 months average at 74%. Now client on-site activities have been limited for March of 2020. Similarly, new car supplies have been disrupted. But we are cautiously optimistic that these will both improve over the course of 2021. It would have been impossible for me to foresee the kind of challenges that the business has faced in my first year as CEO. Yet I can say we're confident that Smartgroup's business model, a well-diversified, long-standing client base and strong customer engagement positions us well for ongoing success. Now allow me to hand back to Matt and provide you with a chance to ask some questions. Thank you.

[Operator Instructions] Our first question will come from Scott Murdoch with Morgans.

Just a couple to kick off with. Just on your leads up 15% on second half, just a couple of things. Just wondering if you're expecting the volume to follow that type of growth that you're seeing. And also just interested in the volume that you're seeing in this first half, how that compares to the pcp in the second half '20.

Thanks, Scott. Yes. Look, it's pleasing that leads' up 15% on the prior 6 months average, but the leads are still down from last year and volumes are still down from last year. So the leads itself, depending on the channel they come through, comes through in varying quality. We are seeing improvements in the quality of the channel that they're coming through. When leads come through the digital process, the digital channel and inbound phones, they do convert at a slightly higher than usual average.

Okay. And just interested in your comments around tighter supply. In practicality, what's the impact of the tighter supply? Are you actually losing deals? Or is it just a delay in the delivery of the cars?

Yes. It's -- I think that's a question that's posed by everyone in our space. And I think from our experience, for example, at various times last year, particularly for example in November, where new car sales, according to VFACTS, went up, depending by brand, depending by model, up 20%, 30% even 40% with some brands. We weren't a beneficiary of that. And part of the answer lies in the consumer wanting cars for December, which is typically school holidays. And we can see that consumers are trending towards a retail channel rather than waiting for cars from us delivered to the wholesale channel. I think that's -- that we're not a beneficiary in that respect. But as the supply chain comes back to some sense of normality, we will be a beneficiary then.

Okay. Just interested if I'm looking at this correctly, the management and admin fee line in the outsourced admin division. That fell half-on-half around 13%, obviously, a lot more than the package number movement. Just interested in -- there's obviously maybe some repricing dynamic there. Just interested if that has fully thrown -- sorry, flowed through. If that's flowed through or if there's more to come.

Thanks for the question. So I guess there's a couple of things at play. One is that in the current lower interest rate environment, we did see a fair bit more -- sorry, a fair bit less interest earned on client fund. So that's also come through independent of package numbers. And then there was a little bit of pricing from a contract negotiations that flowed through as well.

Okay. Just one more, and then I'll pass it over. Just interested in the comments on the cost base around any new hires. If we look, I guess, at that expense base in the second half, it seems like the run rate is a lot lower than your stated, $4 million, cost out. So just interested to how we should look at that second half run rate, and any other extra hires to come through from this point.

Sure. I mean we've highlighted a $4 million annual cost savings versus 2019. We do have quite a lot of vacancies there. In addition to that, the half 2 sales performance was somewhat lower than 2019, and that meant that there was less commissions paid. So it's really the addition of those things. Once we get the volume back, and we're at full commission rates and we get those vacancies back in, that's when we think the $4 million annual cost savings will be seen.